More than income in – income out: fiscal sustainability requires vision for the society we want to live in.

Fiscal sustainability is the ability of a government to sustain its current spending, tax and other policies in the long run without threatening government solvency or defaulting on some of its liabilities or promised expenditures.

Simply put, fiscal sustainability is about ensuring the government is able to spend money and collect tax revenues in a way that doesn’t send the country broke.

The Commonwealth Treasury in its latest Intergenerational Report highlighted that over the longer term, Australia had been heading, under the previous Government, towards sustained and expanding budget deficits, and was expected to reach 12 percent of GDP by FY2055, with Government net debt expanding to 122 percent of GDP.

However, the report also indicated that the policies proposed by the current Government would reverse that potential outcome, and from about 2020 it would achieve about one percent surpluses going forward to FY2055. Correspondingly, we would accumulate net savings of about 10 percent of GDP, and not have any public debt.

Regardless of who’s right – an actual outcome is likely to be somewhere between these two extremes . A more immediate focus is what is the fiscal outlook in the near to medium term?

You’ll probably have heard economists say it’s important to balance the budget over the economic cycle, which means it’s reasonable, and sometimes imperative, to achieve a budget deficit in periods when the economy is weak, and correspondingly seek to achieve a surplus when the economy is strong. But overall revenues and expenses should balance over time.

For FY14, Australia recorded a deficit of nearly $50BN, which represented about 3 percent of GDP, and the latest budget estimates that we’ll continue to run deficits over the short term, achieving a ‘balanced budget’ by FY20, and small surpluses of about 0.5 percent of GDP into the medium term.

If we think about this as a household, or as individuals, it’s simply making sure you don’t spend more than you earn in a sustained way, differentiating between spending on consumption and spending on assets.

So if you’re starting to spend more than you earn, you’ve got really three options (or combinations of these):

Go out and try to earn more;

Spend less;

Rack up the credit card debt.

In terms of achieving fiscal sustainability as a government you essentially have the same three options or combination of options:

Grow the economy so it pays more tax; or simply tax the same economy more;

Cut government spending;

Increase government debt.

Before we start talking about those options in detail it’s important to put some of these issues into context.

For FY15:

Australian economy = $1.6 TN

Government receipts = $377 BN (23.5 percent of GDP)

Government payments = $415 BN (25.9 percent of GDP)

Underlying cash balance = $41 BN (2.6 percent of GDP)

Net Government debt = $285BN (18 percent of GDP)

Government receipts are broken into:

Tax receipts; and

Sales of goods and services, interest received, dividends, etc.

Tax receipts are about $350BN, and make up the vast majority of the $377BN of government income. Tax receipts are predominately made up from:

Income tax ~$175BN

Company Tax ~ $70BN

Excise & Customs ~$35BN

GST ~ $50BN,

In the context of fiscal sustainability, you need to appreciate that taxes are distortionary, and different taxes have different levels of efficiency. The narrower the tax base is, and/or the more mobile the tax base is, the higher is the expected loss of economic welfare associated with those designed taxes. This fundamentally means that if a government attempts to tax their mobile assets too much, they are likely to move to another country where the taxes are less.

Australia’s tax mix at the moment is more dependent on income taxes and company taxes – taxes on mobile assets – than most other countries; and is less dependent on consumption taxes – taxes on broad based activities.

Tax reform is currently on the Government’s agenda, and I would encourage you to read KPMG’s submission in response to the Tax White Paper.

Getting back to the issues of fiscal sustainability. . .

If we can’t tax our people more, then we have look at how much we spend, and on what. I mentioned before Government expenditure for FY15 is estimated to be about $415BN.

The big expenditure items are:

Social security and welfare ~$150BN

Health ~$70BN

State payments for GST ~50BN (in/out)

Education ~$30BN

Defence ~25BN

Running the Government ~25BN

So if we need to cut expenditure, where do we start?

This opens up real questions about what type of society do we want to live in, and therefore pay for:

Do we want to provide a safety net for those less fortunate in society?

What type of health system do we want to offer?

What sort of education are we wanting for our kids?

How do we propose to defend ourselves?

Do we want a big or small Government?

Depending on how we answer those questions impacts on how much money we need to spend, and then how much tax we need to raise.

The alternative of course is to put all the excess expenditure on the Government Amex card.

We can do that, for a bit. But again, it’s important to know what our card limit should be, and also what’s our current balance. Also, just like you and me, if a country borrows money it has to be able to meet the interest payments, and over time, pay the debt back.

Australia’s net debt is about $250BN, or about 16 percent of GDP. This seems pretty low when you hear about the debt positions of other countries – Japan (250 percent), Greece (180 percent), US (100 percent) just to name a few.

Yes that’s true, but there’s a couple of things to recognise about national debt.

A country’s debt compromises four elements; government, household, corporate and financial. Not just government debt. If we ignore financial sector debt, then Australia’s debt to GDP ratio is about 210/220 percent*, and has increased by 33 percent since the onset of the GFC.

Australia has the third highest household debt in the world – only Denmark and the Netherlands have higher household debt. Even the US, UK and Ireland have lower household debt levels than us.

What this tells me is that we have privatised our debt, rather than socialised our debt.

The implication for this is that the current taxpayer is actually using their income to pay off their own private debt, and there is little if any left over to pay for any increase in Government borrowings.

So on paper it looks like we have low government debt levels and can borrow a lot more compared to other countries, but the reality is we can’t really afford to use the Government Amex as we’re more than maxed out on the family MasterCard.

Fiscal sustainability is really about juggling the needs of today, with the expected needs of tomorrow, without biting the hand that feeds us, or leaving a massive bill for our kids to sort out.